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Friday, June 19, 2009

Ecuador: Dollarization on the chopping block

by Chloe Hayward, Euromoney, June 2009

Correa considers new currency regime; Oil price collapse stifles growth

Ecuador’s president, Rafael Correa, is a step closer to dropping dollarization, according to analysts.

"It’s definitely realistic that Correa will start looking at ways to get rid of dollarization," says David Dowsett, senior portfolio manager at BlueBay Asset Management. "He would prefer to not be in charge of a dollarized economy. At the moment it is potentially too risky but it is difficult to say anything with certainty. In time I could definitely foresee a situation where Correa will take this route away from dollarization." By using the dollar as the national currency, Ecuador’s central bank lacks the ability to print money and stimulate growth. In 2008 public spending drove Ecuador’s growth of 6.5%. This year Correa’s government expects the economy to grow only 2.5%.

The slow-down is largely a result of the collapse in the oil price since mid-2008, although the commodity markets are showing signs of recovery. Oil accounts for more than 50% of Ecuador’s fiscal accounts and central bank foreign reserves have tumbled 30% since December 2008.

Two years ago Correa announced that he thought dollarization, which was adopted in 2000, was a "complete failure". However in April he said: "We have said that we will maintain the dollarization system, and as an economist I know how to do that." But Correa’s pledge is likely to have been rattled by recent banking data. Ecuador’s banking system has seen its profits tumble since Correa defaulted on the country’s 2012 and 2030 bonds six months ago.

In the first four months of 2009, the combined net profit for the 24 private banks and one state bank that operate in Ecuador was $72.3 million, according to a report from the local regulator. Banco del Pichincha topped the list with $17.75 million. In the same time period, deposits in the financial system have reportedly fallen by around $750 million. According to Fernando Pozo, chief executive of Banco del Pichincha and the head of the association of banks in Ecuador, this decline in deposits has been partly driven by a drop off in remittances.

The economic slow-down will put further pressure on the banks, which have taken their own measures to try and avoid increasing bad-debt ratios by restricting new loans and increasing interest rates on personal loans. This year loans have slid 7.3% already.

But the timing of Correa’s move out of dollarization is still uncertain. "The government is worried about the implications of a disorderly exit from the dollar," says Patrick Esteruelas, Latin American analyst at Eurasia Group. "Correa has even opened the vaults of the central bank to dispel widespread rumours that cargo containers delivered coinage for the new currency that he planned to introduce after the elections. But Correa’s current policy mix is incompatible with dollarization. If oil prices drop and credit lines dry up Correa will face one of two choices in the coming months – to eat some humble pie and ask the IMF for money or de-dollarize. But I don’t think this trade-off will happen this year."

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